A Ban on Surge Pricing will Create Shortages

By Anupam Manur (@anupammanur)

Instead of a price ceiling on cab prices, the government should look at all the ways in which it can increase the travel options within the city.

Karnataka’s Transport Minister Ramalinga Reddy recently unveiled a new policy to regulate cab aggregator services such as Uber and Ola. While Karnataka previously had a policy to regulate regular taxis as ride-hailing services under Radio Taxi Scheme, 1988, Uber and Ola were not covered under the law, as they were aggregator services and not companies that own and operate vehicles for hire. However, as the app-based on-demand cab aggregator companies became increasingly popular, the government sought to bring them under the regulatory ambit.

The policy has introduced a few concessions for the cab aggregators, in a move to increase the supply of cabs. They have dropped the restrictions on the age of the vehicles, reduced the number of years that a driver had to be a resident in Karnataka from five to two, and has allowed drivers to switch between the ride hailing apps, as per their choice. They have also halved the license fee and security deposit. All of these moves will benefit the companies and the customers alike.

However, the biggest policy that will have a detrimental effect on the state of urban transport in Bangalore is the decision to disallow surge pricing for these companies. Both Uber and Ola use an algorithm to determine the prices based on real time demand and supply. If the demand for cabs were considerably higher than the supply, then the app would tell the customer that prices have surged. The surge pricing not only reduced demand, but is also a tool to increase the supply. A higher price will automatically incentivise more drivers to go to the area with surge pricing. However, the surge prices can, at times, be quite ridiculous, which is what caught the authorities’ attention. On New Year’s Eve, for example, Uber had a surge pricing of 10X, that is, ten times the normal amount.

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Effectively, the government has put a price ceiling on what these companies can charge the customer. It has given a band with a fixed upper limit, within which the price charged to the customer has to fall. While, this might seem like something to cheer about for the customer at the first glance, a closer inspection will reveal that it will actually end up hurting the customer as well as the companies.

Price ceilings simply do not work, as economic history has repeatedly taught us. A price ceiling will simply create a shortage in the supply of the good in question and create distortions in the market, which will hurt the very customer that such laws are intended to protect. In this case, a ban on surge pricing will lead to a reduction in the number of taxis available in the market, thereby creating welfare loss to the customers who demand the taxis.

The supply of any commodity depends on the price. At each price point, a supplier (driver in this case) will decide whether it is profitable to sell at that price point. Auto rickshaws normally charge 1.5X from 9PM — 6AM, in a bid to be compensated for working late hours and at times that other would not be willing to. Imagine if a similar price cap had been put in place for autos, there wouldn’t be any autos available for hire after 9PM.

Similarly, during peak hours and other times of high demand, in the absence of surge pricing, an Uber driver would not consider it worthwhile to switch on the app or accept ride requests and thus, leading to shortages.

Another major impact of this ruling would be that Bangalore would lose out on the new investment that these companies had pledged. Uber, which has now partnered with 30,000 cabs in the city had planned to expand to about 1,00,000 cabs in the next few years. Uber and Ola combined had pledged to invest around Rs. 15,000 crores in the next few years in Karnataka. With regressive laws such as this, the state could easily lose this investment to neighbouring states. The other worry is that other Indian states could follow this bad example. Maharastra was considering a similar move and it could get buoyed by the Karnataka move.

Finally, the government must rethink whether this is the best method to achieve its objectives. The intention behind this move is to increase the supply of public transport at affordable rates for the consumers. Instead of creating distortions in the market by implementing a price cap, the government should look at other ways to make the market more competitive and remove entry barriers. The government could consider allowing flag down taxis on the streets, like they have in all other major metros in India, which will surely increase the supply of taxis. It could also allow shared autos to ply on Bangalore roads for fixed routes, which will ease the demand for taxis. Another related measure is to allow private busses of all sizes on Bangalore roads, which is currently disallowed. In short, the government should look at all ways to improve public transport in Bangalore and ways to increase the number of options available for customers to travel in the city. This will surely reduce the excess demand for Uber and Ola, which will automatically make surge pricing redundant.

Anupam Manur is a Policy Analyst at the Takshashila Institution.

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